Chapter7 intangibleassets2008

Gripping IFRS Intangible Assets

Chapter 7
Intangible Assets

Reference: IAS 38, SIC 32 and IFRS 3

Contents: Page

1. Introduction 261

2. Definitions and recognition criteria 261

3. Recognition of an intangible asset 263
3.1 The item must be without physical substance 263
Example 1: recognition of a fishing licence 263
Example 2: recognition of software 263
3.2 The item must be identifiable 264
3.3 The item must be controllable 264
Example 3: recognition of training costs 264

4. Initial measurement 265
4.1 Initial expenditure 265
4.1.1 Acquired separately for cash 266
4.1.2 Acquired separately by way of an exchange of assets 266
4.1.3 Acquired as part of a business combination 266
Example 4: intangible asset acquired in a business combination 267
4.1.4 Acquired by way of a government grant 268
4.1.5 Internally generated intangible assets 268
4.1.5.1 Internally generated goodwill 268
4.1.5.2 Internally generated intangible assets other than goodwill 269
4.1.5.2.1 The research phase 270
4.1.5.2.2 The development phase 270
4.1.5.2.3 The production phase 271
Example 5: research and development 271
4.1.5.2.4 Web site costs 272
4.1.5.2.5 In-process research and development 274
Example 6: in-process research and development acquired 274
4.2 Subsequent expenditure 275

5. Measurement models 275
5.1 Cost model 275
5.2 Revaluation model 275
5.2.1 Accounting for a revaluation 276

6. Amortisation and impairment testing 276
6.1 Overview 276
6.2 Impairment testing 277
6.3 Amortisation 277
6.3.1 Depreciable amount and the residual value 277
6.3.2 Period of amortisation 278
Example 7: renewable rights 278
6.3.3 Method of amortisation 279
6.4 Annual review 279
6.5 Intangible assets with indefinite useful lives 279
6.6 Intangible assets not yet available for use 279

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Contents continued … Page

7. Disclosure 280
7.1 In general 280
7.2 Sample disclosure involving intangible assets (excluding goodwill) 281

8. Goodwill 284
8.1 Overview 284
8.2 Internally generated goodwill 284
8.3 Purchased goodwill 285
8.3.1 Positive goodwill 285
Example 8: positive purchased goodwill 285
8.3.2 Negative goodwill 285
Example 9: negative purchased goodwill 286
8.3.3 Initial recognition determined provisionally 286
Example 10: provisional accounting of fair values 286
8.3.4 Adjustment in the initial accounting 287
8.4 Disclosure of goodwill 288
8.4.1 Disclosure: positive goodwill 288
8.4.2 Disclosure: negative goodwill 288
8.4.3 Sample disclosure involving goodwill 288

9. Summary 290

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1. Introduction

The standard on intangible assets (IAS 38) covers all intangible assets unless the asset:
• is covered by another accounting standard (e.g. inventories, deferred tax assets, leases,
goodwill, employee benefits, non current assets held for sale and financial assets);
• relates to mineral rights and expenditure on the exploration for, or development and
extraction of non-regenerative resources such as minerals and oils.

‘Intangible’ is defined in the Oxford dictionary as ‘unable to be touched’: this chapter is
therefore dedicated to those assets that have no physical form. Examples of assets without
physical substance include, inter alia, research and development costs, software, patents,
trademarks, copyrights, brands, licences and training. These items, however, must meet the
definition and recognition criteria provided in IAS 38 before they are recognised as an asset. If
these are not fully met, it will result in an intangible item being expensed.

Cost incurred on intangible items
are either:

Expensed Capitalised (asset)

Some items, covered by other standards, are specifically excluded from this standard (IAS 38):
• deferred tax assets
• leases
• employee benefits; and
• goodwill from business combinations.

2. Definitions and recognition criteria (IAS 38 and the Framework)

The following definitions are provided in IAS 38 and/ or the Framework (some of these have
been simplified so as to be easier to read):

Intangible asset:
• an identifiable
• non-monetary
• asset (refer below)
• without physical substance.

Asset (from the Framework):
• a resource
• controlled by an entity
• as a result of past events; and
• from which future economic benefits are expected to flow to the entity.

Recognition criteria (from IAS 38 and in the Framework):
• the future economic benefits expected must be probable; and
• the asset must have a cost that is reliably measurable.

Monetary assets are:
• money held and
• assets to be received in fixed or determinable amounts of money.

Amortisation:
• is the systematic allocation of the depreciable amount of an intangible asset
• over its useful life.

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Depreciable Amount:
• is the cost of an asset, or other amount substituted for cost,
• less its residual value.

Cost:
• is the amount of cash or cash equivalents paid or
• the fair value of the other consideration
• given to acquire an asset
• at the time of its acquisition or construction’, or
• when applicable, the amount attributable to that asset when initially recognised in
accordance with the specific requirements of other IFRSs eg IFRS 2 Share-based payments.

Residual Value:
• of an intangible asset is
• the estimated amount that the entity would currently obtain from disposal of the asset,
• after deducting the estimated costs of disposal,
• if the asset were already of the age and in the condition expected at
• the end of its estimated useful life.

Useful Life:
• is the period of time over which an asset is expected to be available for use by the entity; or
• the number of production or similar units the entity expects to obtain from the asset.

Impairment Loss:
• is the amount by which
• the carrying amount of an asset
• exceeds its recoverable amount.

Carrying Amount:
• is the amount at which an asset is recognised in the statement of financial position
• after deducting any accumulated amortisation and accumulated impairment losses thereon.

Recoverable Amount (given in IAS 36 and repeated here for your convenience):
• of an asset or a cash-generating unit is
• the higher of
• its fair value less costs to sell and
• its value in use.

Fair Value:
• is the amount for which that asset could be exchanged
• between knowledgeable, willing parties in an arm’s length transaction.

Active Market:
• is a market in which all the following conditions exist:
a) the items traded in the market are homogenous;
b) willing buyers and sellers can normally be found at any time; and
c) prices are available to the public.

Research:
• is original and planned investigation
• undertaken with the prospect of gaining new scientific or technical knowledge and
understanding.

Development:
• is the application of research findings or other knowledge
• to a plan or design for the production
• of new or substantially improved materials, devices, products, processes, systems or
services before the start of commercial production or use.

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3. Recognition of an intangible asset (IAS 38.9 - .17)

Before an intangible item may be recognised as an intangible asset, it must meet the:
• definition of an intangible asset (and thus also the definition of an ‘asset’ per the
Framework); and
• recognition criteria.

The most difficult aspects to meet regarding the definition of an intangible asset are generally
the following:
• the asset must not have a physical form (this is not always that obvious);
• the asset must be ‘identifiable’; and
• the asset must be controlled by the entity.

One of the most difficult aspects of the recognition criteria to meet is that
• the value thereof must be ‘reliably measurable’.

This aspect is problematic where the intangible asset is made and is therefore not purchased as
an individual asset. In such a case there would therefore not be a purchase price and therefore
one would needs to estimate a fair value.

3.1 The item must be without physical substance

Expenditure is frequently incurred on items that have both intangible and tangible elements.
This requires assessing which element is more significant: the physical (tangible) or the non-
physical (intangible) element. Depending on which element is more significant will determine
which standard should be applied to the asset:
• the standard on Intangible Assets (IAS 38) or
• the standard on Property, Plant and Equipment (IAS 16) or another appropriate standard.

Example 1: recognition of a fishing licence

A company has acquired a fishing licence. The directors insist that it is a physical asset since it
is written on a piece of paper. State and briefly explain whether or not you would recognise a
fishing licence as an intangible asset.

Solution to example 1: recognition of a fishing licence

Although the fishing licence has a physical form, (the related legal documentation), the licence is
considered intangible rather than tangible since the most significant aspect is the licenced ‘ability’ to
fish rather than the physical proof thereof. Such a right (whether documented or not) is always
considered to be intangible.

Example 2: recognition of software

State and briefly explain whether or not you would recognise software as an intangible asset if
it is incorporated into a machine that is dependent on the software for its operation.

Solution to example 2: recognition of software

The most significant element would be considered to be the tangible machine, since the software is
considered integral to the machine, and therefore the cost of the software would be recognised as part of
the cost of the machine and therefore classified as property, plant and equipment (IAS 16). If the
software was ‘stand-alone’ software rather than ‘in the machine’, it would have been classified as an
intangible asset (IAS 38)

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3.2 The item must be identifiable

Another important aspect of the definition of ‘intangible assets’ (per IAS 38) is that the asset
must be identifiable (IAS 38.11). An asset is considered to be identifiable if it (IAS 38.12):
• is ‘separable’, i.e. is capable of being separated or divided from the entity and sold,
transferred, licensed, rented or exchanged, either individually or together with a related
contract, asset or liability; OR
• arises from contractual or other legal rights, regardless of whether those rights are
transferable or separable from the entity or from other rights and obligations.

If one cannot prove that the asset is identifiable it may not be recognised as a separate asset.
Examples of items that are not considered ‘identifiable’ include advertising and staff training
since these costs are impossible to separate from the general running costs of a business and
are therefore considered to be part of internally generated goodwill and are thus expensed.

If the asset is not separately identifiable and is acquired as part of a business combination, then
the asset will form part of goodwill. Goodwill is not covered by the standard on ‘intangible
assets’ but rather by the standard on ‘business combinations’ (IFRS 3). Since, however,
goodwill is closely linked to intangible assets, it is discussed later in this chapter.

3.3 The item must be controllable

The definition of an ‘intangible asset’ includes reference to an asset and therefore the
definition of an ‘asset’ (per the Framework) must also be met. This means that the intangible
asset must be controlled by the entity as a result of a past event and must result in an expected
inflow of future economic benefits (either through increased revenue or decreased costs).

Control over an intangible asset is difficult to prove. It may, however, be achieved if the entity
has (IAS 38.13):
• the ability to restrict access to the asset and its related future economic benefits; and
• the power to obtain the related future economic benefits, (generally through legally
enforceable rights e.g. copyright).

Legal rights are not necessary to prove control: it is just more difficult to prove controllability
without them.

By way of example, an entity may be able to identify a team of skilled staff, a portfolio of
customers, market share or technical knowledge that will give rise to future economic benefits.
The lack of control, however, over the flow of future economic benefits means that these items
seldom meet the definition of an intangible asset. Control over technical knowledge and
market knowledge may be protected by legal rights such as copyrights and restraint of trade
agreements, in which case these would meet the requirement of control.

Example 3: recognition of training costs

State and briefly explain whether or not you would recognise training costs as an intangible
asset.

Solution to example 3: recognition of training costs

Although training may be considered to be expenditure on an identifiable, non-monetary item that is
without physical substance (therefore ‘intangible’ per IAS 38), the definition of an asset is not met in
terms of the Framework since the trained staff members may not necessarily be under sufficient control
of the entity to be considered to be an ‘asset’.

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4. Initial measurement (IAS 38.18 - .67)

4.1 Initial expenditure

The amount at which an intangible asset that meets both the definition and recognition criteria
is initially recorded is its cost (in cash or its fair value) (IAS 38.24).

Costs should be capitalised only where they are incurred in bringing the asset to a location and
condition that enables it to be used as intended by management. This means that income and
expenses from incidental operations occurring before or during development or acquisition of
an intangible asset are recognised in profit or loss, and not capitalised (cost would be expensed
instead of recognised as assets).

Capitalisation of costs ceases once the asset is brought to a location and condition that enables
it to be used as intended by management. This means that any costs incurred in using or
redeploying the asset are not capitalised. ‘Initial operating losses incurred while demand for
the asset’s output builds up’ would also not be capitalised (since this occurs subsequent to the
asset being brought into use). (IAS 38.30)

The calculation of the cost depends on how the intangible asset was acquired:
• acquired separately for cash
• acquired separately by way of an exchange of assets
• acquired as part of a business combination
• acquired by way of a government grant
• internally generated.

This can be summarised as follows:

Intangible assets can be

Acquired: Internally generated
• Purchased for cash
• Purchased by exchanging another
asset
• Purchased in a business
combination
• By a government grant

Measurement of the cost may require the fair value to be determined, if the intangible asset
was not acquired separately for cash.

This ‘fair value’ must be determined on the date of acquisition whether an active market exists
or not:
• If an active market exists, the fair value will:
- usually be the current bid price or, if unavailable, then the price of the most recent
similar transaction (so long as there has not been a significant change in economic
circumstances between the last transaction date and the date of acquisition of the
intangible asset) (IAS 38.39);
• If an active market does not exist, the fair value will either be:
- the amount that would have been paid for the asset at the date of acquisition, in an
arm’s length transaction between knowledgeable and willing parties; or
- another method of calculating the estimated fair value (e.g. discounted cash flow
projections) so long as a reliable estimate results (IAS 38.40).

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It is interesting to note that, due to the unique nature of most intangible assets, a fair value is
often impossible to determine with reference to an active market:
• there will be no current bid price since the assets traded are unique (as opposed to
homogenous) and, as a result, sales thereof are generally negotiated as once-off private
transactions (and therefore prices will also not be available to the public); and
• there will generally be no similar transaction to compare it to.

A prime example is that of brands: every brand in existence is unique by nature and therefore
no active market for it could exist and neither could there be a similar transaction that could be
used as an alternative guideline to its value.

4.1.1 Acquired separately for cash (IAS 38.25 - .32)

If the asset was acquired on an individual basis (i.e. not as part of a ‘bundle of assets’) for
cash, the cost will be relatively easy to measure (as detailed above):
• its purchase price (net of trade discounts and rebates);
• import duties and non-refundable taxes; and
• any costs directly attributable to bringing the asset to a condition enabling it to be used.

4.1.2 Acquired separately by way of an exchange of assets (IAS 38.45 - .47)

In the case of the exchange of assets, the cost of the intangible asset acquired will be a fair
value, determined as the:
• fair value of the asset given up;
• fair value of the acquired asset if this is more clearly evident; or the
• carrying amount of the asset given up if neither of the fair values are available or the
transaction lacks commercial substance.

For examples on the exchange of assets, see the chapter on property, plant and equipment.

4.1.3 Acquired as part of a business combination (IAS 38.33 - .43 and .48)

When one entity, say A, acquires another entity, say B, it acquires the assets and liabilities of
B, including any intangible assets previously belonging to B. The cost of each intangible asset
acquired in a business combination is its fair value on date of acquisition.

The acquirer (A) must recognise each intangible asset acquired, whether or not it was
previously recognised in the books of the acquiree (B), if:
• it meets the intangible asset definition and
• has a fair value that can be measured reliably (i.e. only one of the recognition criteria
needs to be met).

If the fair value is reliably measurable, there is no need to prove that the future flow of future
economic benefits is probable because it is accepted that the fair value is the market
expectation of the probable flow of future economic benefits.

Internally generated goodwill is prohibited from being capitalised by the company that created
it. This is because the costs of generating goodwill are inextricably mixed up with the
expenses incurred in running a business i.e. there is no reliable way of separating the portion
of the costs that relate to the creation of the goodwill from the general running costs (e.g. cost
of advertising, training staff and pleasing customers). This mix up with the normal running
expenses means that the intangible asset cannot meet the requirement of being ‘separable’.

When, however, an entity is purchased for a price that is more than the fair value of the net
assets, this excess is goodwill, (an intangible asset), that is recognised in the acquirer’s books
as ‘purchased goodwill’:
• Purchase price paid for entity – net asset value of entity = goodwill (purchased)

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In other words, the company that created the goodwill may never recognise it as an asset in its
own books, but if another company buys that company and pays a premium, this premium,
being purchased goodwill, may be recognised as an asset in the purchaser’s books. The logic
behind this is that by buying a company at a premium over the fair value of its assets means
that a reliable measure of its value has been established.

If one or more of the intangible assets does not meet the definition or recognition criteria in
full (e.g. an active market does not exist and the cost is not able to be measured reliably in any
other way), then its value is excluded from the ‘net asset value of the entity’ and the value of
the intangible asset is effectively incorporated into the purchased goodwill.

Example 4: intangible asset acquired in a business combination

Company A acquires company B. The net assets and liabilities of B are as follows:
• property, plant and equipment C500 000 Fair value
• patent C100 000 See the required below
• liabilities C200 000 Fair value

The price paid for company B is C700 000.

Required:
Journalise the acquisition of company B in the books of company A assuming:
A. the fair value of the patent is reliably measurable at C100 000;
B. the fair value of the patent is not reliably measurable and the value given above
(C100 000) is therefore the carrying amount based on the depreciated cost to company B;
and
C. the purchase price of the company was C300 000 (not C700 000) and all values provided
are fair values.

Solution to example 4A: intangible asset acquired in a business combination

Calculations/ comments Debit Credit
Property, plant and equipment Given 500 000
Patent Given: FV measured reliably at 100 100 000
000
Liabilities Given 200 000
Bank Given 700 000
Goodwill (Asset) Balancing 300 000
Acquisition of company B

Solution to example 4B: intangible asset acquired in a business combination

Bank Given 700 000
Goodwill (Asset) Balancing 400 000

Notice that the patent is not recognised (because its fair value of 100 000 was not measured reliably).

Also notice how this results in the increase in the goodwill amount (from C300 000, in the solution to
part 4A, to C400 000).

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Solution to example 4C: intangible asset acquired in a business combination
Patent Given: fair value measured reliably 100 000
Bank Given: revised in part C to 300 000 300 000
Goodwill (Income) Balancing 100 000
Notice that the goodwill is credited: this is commonly referred to as negative goodwill but is officially
termed excess of acquirer’s interest in the net fair value of acquiree’s identifiable assets, liabilities
and contingent liabilities over cost.
Also notice that negative goodwill is recognised immediately as income (rather than as an asset as in
part A and B of this example). This is recognised as income because the company paid less for the
company than its net asset value and therefore it effectively made a profit on the acquisition.

4.1.4 Acquired by way of a government grant (IAS 38.44)

On occasion, the government may grant an entity an intangible asset, such as a broadcasting
licence to the South African Broadcasting Corporation. This asset may be granted either at no
charge or at a nominal amount.

The value at which such an intangible asset is initially recorded may either be:
• the fair value of the asset acquired, or
• the nominal amount plus any expenditure necessarily incurred in order to bring the asset to
the location and condition necessary for its intended use.

For further information on intangible assets acquired by way of a government grant, please see
the chapter entitled Government Grants.

4.1.5 Internally generated intangible assets (IAS 38.48 - .67)
A company may expend resources on the internal creation of intangible items. Examples of
such internal items include patents, trademarks, customer loyalty and market share. Some of
these intangible items contribute towards the entity’s goodwill. These items will be referred to
as ‘internally generated goodwill’ and the balance, for ease of reference, will be referred to as
‘internally generated intangible assets other than goodwill’.

4.1.5.1 Internally generated goodwill (IAS 38.48-50)

Not all expenditure incurred on creating an intangible item may be capitalised as an intangible
asset. Examples of such expenditure include the costs involved in developing customer
loyalty, market share and other items that generally lead to the development of the business as
a whole. These items are defined as internally generated goodwill and are always expensed.
Internally generated goodwill is never recognised as an asset and is always expensed.
Although this goodwill is expected to render future economic benefits, it may not be
capitalised because it does not completely meet the asset definition and recognition criteria:
• it is not an identifiable resource (i.e. it is not separable from the costs of running a
business and it does not arise from any contractual or legal right);
• it may not be possible to control items such as customer loyalty; and more importantly
• it is impossible to reliably measure the value thereof.
It is interesting to contrast the expensing of internally generated goodwill with the
capitalisation of purchased goodwill (covered in IFRS 3):
• Purchase price of entity - net asset value of entity = goodwill (purchased)

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Although it may seem that the above equation could be adapted to measure internally
generated goodwill by replacing ‘purchase price’ with ‘market value’ of the entity, this would
not be acceptable because:
• the market value is as a result of a wide range of factors (including, for instance, the
economic state of the country), not all of which relate to the customer loyalty or other
items forming part of internally generated goodwill; and
• there is no control over any of these factors, for example, the economic state of the
country or customer loyalty.

4.1.5.2 Internally generated intangible assets other than goodwill (IAS 38.51-67)

A company may have an intangible item that has been internally generated. There are three
distinct phases that need to be discussed:
• research (IAS 38.54);
• development (IAS 38.57); and
• production.

Once the research phase is successfully completed, the development phase may begin, the
successful completion of which then leads to the start of the production phase (or when the
intangible asset begins to be used in some or other way).

Research

Development

Completion and/ or production

The following internally generated items must never be capitalised: (IAS 38.63)
• goodwill;
• brands;
• mastheads;
• publishing titles;
• customer lists; and
• other similar items.

The reason for this is that these items form part of the general costs of creating a business (i.e.
they are not separately identifiable from developing the business as a whole) and should
therefore be expensed (IAS 38.64).

Once the item meets the definitions and recognition criteria, the next step is to determine
which of the costs may be capitalised. Costs that may be capitalised are only those that are:
• directly attributable
• to preparing the asset for its intended use.

Some costs may be excluded on the grounds that they are:
• costs not directly associated with preparing the asset for its intended use: for example,
selling costs and general overheads are generally not directly attributable to the asset and
are therefore normally not capitalised;
• costs incurred after the asset was brought to a condition that enabled it to be used as
intended by management, (unless these costs meet the recognition criteria): for example
costs of moving an asset to another location; costs incurred while an asset, capable of
being used, remains idle and initial operating losses;
• costs of training staff to operate the asset; and
• costs that were expensed in a previous financial period due to all criteria for capitalisation
not being met, even if all criteria are subsequently met.

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Since the internally generated item must meet the recognition criteria, the accounting
treatment of each phase (research, development and production) will differ based on the
abilities to prove that future economic benefits are probable. This is now discussed further.

4.1.5.2.1 The research phase:

Research is defined as:
• original and planned investigation
• undertaken with the prospect of gaining
• new scientific or technical knowledge and understanding.

By definition, this is the very early stage of the creation of the intangible item, where research is
merely a project to investigate whether there are possible future economic benefits. There is
therefore no guarantee at this stage that the future economic benefits are expected (definition) or
probable (recognition criteria). Research costs are therefore always expensed (IAS 38.54).

Examples of research activities include (IAS 38.56):
• activities aimed at obtaining new knowledge;
• the search for, evaluation and final selection of applications of research findings or other
knowledge;
• the search for alternatives for materials, devices, products, processes, systems or services;
• the formulation, design, evaluation and final selection of possible alternatives for new or
improved materials, devices, products, processes, systems or services.

4.1.5.2.2 The development phase:

Development is defined as:
• the application
• of research findings or other knowledge
• to a plan or design for the production
• of new or substantially improved materials, devices, products, processes, systems or services
• prior to the commencement of commercial production or use.

Since development is the second, and therefore more advanced stage of creation, it may be
possible to prove that the item is expected to generate future economic benefits. In order for this
to be proved, all of the following criteria need to be demonstrated (i.e. proved) (IAS 38.57):
• the technical feasibility of completing the asset;
• the intention to complete the asset and to either use or sell it;
• the ability to use or sell the asset;
• how the asset will generate future economic benefits, through, for instance, demonstrating
that there is a market to sell to, or if the asset is to be used internally, then its usefulness;
• the adequate availability of necessary resources (technical, financial or otherwise) to
complete the development and to sell or use the asset; and
• the ability to reliably measure the cost of the development of the asset.

If just one of these criteria is not demonstrable, then the related costs must be expensed.

Once all these criteria are met, however, it can be said that future economic benefits are probable
and that there is a cost that is reliably measurable. Assuming the two definitions (asset and
intangible asset) are also met, the item must be capitalised.

Development costs
are either:

Expensed Capitalised (asset)
(if one or more of the 6 criteria are not met) (if all 6 recognition criteria are met)

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Examples of development activities include (IAS 38.59):
• the design, construction and testing of pre-production or pre-use prototypes and models;
• the design of tools, jigs, moulds and dies involving new technology;
• the design, construction and operation of a pilot plant that is not of a scale economically
feasible for commercial production; and
• the design, construction and testing of a chosen alternative for new or improved materials,
devices, products, processes, systems or services.

4.1.5.2.3 The production phase:

Once the development phase is complete, the economic benefits from the use of the
development asset can start to flow into the entity. In order to achieve a better reflection of the
diminishing value of the asset as a result of usage, the development asset should be amortised.

The amortisation of the development asset must begin as soon as it is ready for use (i.e. when
development is complete). It therefore does not matter when we actually start production.

If when production starts, the development asset is used in the production of another item that
will first have to be used or sold before economic benefits are earned, then the amortisation
should be capitalised to the cost of this item/s. This amortisation will eventually be expensed
when this item is used or sold (e.g. development costs incurred in relation to inventory will be
expensed as cost of sales when the inventory is sold).

Example 5: research and development

A company entered into a research and development project, the costs of
which are as follows (all costs are incurred evenly over the year): C
20X1: 120 000
20X2: 100 000
20X3: 100 000
On 1 September 20X1, the recognition criteria for capitalisation of development costs are met.

The recoverable amounts are as follows: C
31 December 20X1 90 000
31 December 20X2 110 000
31 December 20X3 250 000

Required:
A. Show all journals related to the costs incurred for each of the years ended 31 December.
B. Disclose the development asset in the statement of financial position for 20X1 to 20X3.

Solution to example 5A: research and development

Summary: cost of development asset account 20X1 20X2 20X3
Opening balance 0 40 000 110 000

Current year’s cost incurred and capitalised 40 000 100 000 100 000
(20X1: C120 000 x 4/12, from 1 September 20X1, when all 6
criteria met)

Subtotal 40 000 140 000 210 000

Compared with recoverable amount (given) 90 000 110 000 250 000
(1)
(Impairment loss)/ impairment loss reversed N/A (30 000) 30 000
(20X1: RA > CA) (20X2: CA of 140 000 – RA of 110 000)
(20X3: RA of 250 000 limited to original costs capitalised of
240 000 – CA of 210 000 = 30 000

Closing balance 40 000 110 000 240 000

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Note 1: The impairment loss reversed is not C40 000 but C30 000 because it is limited to the
impairment loss originally recognised. If an impairment loss reversed were to be measured at C40 000,
the balance on the development asset at 31 December 20X3 would land up at C250 000 (instead of
C240 000) and yet only C240 000 development costs were incurred:

Actual development costs C
20X1 (C120 000 x 4/12) 40 000
20X2 (given) 100 000
20X3 (given) 100 000
240 000

20X1 Debit Credit
Research (E) 120 000 x 8/12 80 000
Development: cost (A) 120 000 x 4/12 40 000
Bank/ liability 120 000
Research and development costs incurred (capitalisation began from
1 September 20X1, being the date on which all six criteria were met
(costs expensed before this date)

20X2
Development: cost (A) 100 000
Development costs incurred

Impairment loss: development (E) CA: 140 000 – RA: 110 000 30 000
Development: accumulated impairment loss: (-’ve A) 30 000
Impairment loss recognised (six criteria still met)

20X3
Development (A) 100 000
Development costs incurred

Development: accumulated impairment loss: (-’ve A) 30 000
Impairment loss reversed: development (I) 30 000
Impairment loss reversed (CA of 210 000 increased to RA of 250 000,
limited to historical carrying amount costs 240 000 (costs capitalised:
40 000 + 100 000 + 100 000 – amortisation: 0)

Solution to example 5B: research and development

ABC Ltd
Statement of financial position
At 31 December 20X3 (extracts)
ASSETS Note 20X3 20X2 20X1
Non-current Assets C C C
Development 3 240 000 110 000 40 000

4.1.5.2.4 Web site costs (SIC 32):

The costs incurred on a business web-site can be categorised into five basic stages:
• Stage 1: Planning stage
• Stage 2: Application and infrastructure stage
• Stage 3: The graphical design stage
• Stage 4: Content development stage
• Stage 5: Operating stage.

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Stage 1: Costs incurred in the planning stage of the web-site (e.g. undertaking feasibility
studies, defining hardware and software specifications) are expensed as research.

Stage 2 – 4: The costs incurred during stages 2 – 4 could potentially be capitalised as
development costs. The same intangible asset definition and six recognition criteria would,
however, first need to be met before the costs could be capitalised as development costs.
Stage 2, being the application and infrastructure development stage involves, for example,
obtaining a domain name, developing server software. Stage 3, being the graphical design
stage involves, for example, designing the layout and colours on the website. Stage 4, being
the content development stage involves, for example, writing information about the entity and
including pictures of products sold. If a link can be established between the cost incurred
during any of these stages (stage 2 – 4) and the inflow of future economic benefits, the cost
could potentially be capitalised (if the definitions and recognition criteria are met). This means
that if the cost incurred on the website simply results in electronic advertising, then the cost
must be expensed. Consider for example, the content development stage:
• the cost of photographing products available for sale would be a cost of advertising and
would therefore be expensed; whereas
• the cost that is a fee for acquiring a licence to reproduce certain information, may be a cost
that could be capitalised (if the definitions and six recognition criteria are met).

Stage 5: The operating stage occurs once the web-site is ready for use. Capitalisation of any
website-related costs must cease during this stage unless they meet the requirements for
capitalisation of subsequent costs (i.e. the definitions and just the two basic recognition criteria
per the Framework are met).

If the company’s web-site is primarily involved in advertising products, then the cost of the
web-site should be expensed as advertising (since it would be impossible to reliably measure
the future economic benefits from the use of the web-site). If the web-site is, on the other
hand, able to take orders, for example, then it may be possible to prove and measure the future
economic benefits expected from the use thereof, in which case it may be possible to capitalise
the associated costs.

Where an entity incurs web-site costs involved in the creation of content other than for
advertising and promotional purposes and this directly attributable cost results in a separately
identifiable asset (e.g. a licence or copyright) this asset should be included in the ‘web-site
development asset’ and should not be separately recognised.

The web-site should be amortised, as the useful life is considered to be finite. The useful life
selected should be short.

Website costs
are either:

Expensed: Capitalised (asset)
If costs incurred in the If costs incurred in the:
• Stage 1: Planning stage • Stage 2: Application and infrastructure stage
• Stage 5: Operating stage • Stage 3: The graphical design stage
• Stages 2 – 4: if the definitions and all • Stage 4: Content development stage
six recognition criteria are not met and all definitions and six recognition criteria met
e.g. a web-site that is electronic advertising e.g. a web-site that can take orders

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4.1.5.2.5 In-process research and development: (IAS 38.34 and .42 - .43)

Whereas many companies do their own research and development, it is possible for a
company to buy another company’s research and development. If a company buys (either
separately or as part of a business combination) another company’s ‘in-process research and
development’ project, the fair value of the initial acquisition costs will be capitalised if it:
• meets the definition of an asset (the basic asset definition provided in the Framework);
• is identifiable (i.e. is separable or arises from contractual or other legal rights); and
• its fair value can be measured reliably.
The entire purchase price is capitalised if the above criteria are met, regardless of the portion
of the fair value that relates to purchased research.

Any subsequent expenditure on this purchased ‘in-process research and development’ project
will, however, be analysed and recognised in the normal way:
• costs that relate to research must be expensed;
• costs that relate to development:
- must be expensed if all recognition criteria are not met; and
- capitalised if all recognition criteria are met.

Example 6: in-process research and development acquired

A company bought an incomplete research and development project from another company
for C400 000 (considered to be a fair value) on 1 January 20X1. The purchase price has been
analysed as follows:
C
Research 100 000
Development 300 000

Subsequent expenditure has been incurred on this project as follows:

Research Further research into possible markets was considered necessary 200 000
Development Incurred evenly throughout the year. All recognition criteria for 480 000
capitalisation as a development asset were met on 1 June 20X1.

Required:
Show all journals related to the in-process research and development for 20X1.

Solution to example 6: in-process research and development acquired

20X1 Debit Credit
Development (A) 400 000
In-process research and development purchased (no differentiation
between research and development is made) when the project was
acquired as ‘in-process R&D’ (IAS 38.34)

Research (E) 200 000
Development (E) [480 000 x 5/12] 200 000
Development (A) [480 000 x 7/12] 280 000
Subsequent expenditure on an in-process research and development
project recognised as usually done: research is expensed and
development costs capitalised only if all criteria for capitalisation of
development costs are met

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4.2 Subsequent expenditure (IAS 38.20 and .42 - .43)

The same criteria are applied to subsequent expenditure and initial expenditure, that is to say,
the costs are capitalised if the following criteria are met:
• The definition of an intangible asset is met and
• It has a value that is reliably measurable and
• It is probable that future economic benefits will flow to the entity.

Due to the nature of intangible assets, it is frequently so difficult to prove that subsequent
expenditure is attributable to a specific intangible asset rather than to the general operation of
the business, that subsequent expenditure on intangible assets is seldom capitalised.

5. Measurement models (IAS 38.72 - .106)

As with tangible assets covered by the statement on property, plant and equipment (IAS 16),
there are two measurement models allowed:
• the cost model; and
• the revaluation model.

5.1 Cost model (IAS 38.74)

The intangible asset is shown at its cost less any accumulated amortisation and any
accumulated impairment losses. Most intangible assets are measured under the cost model
because the fair value needed for the revaluation model is not easily determinable.

5.2 Revaluation model (IAS 38.75 - 87)
If the intangible asset is measured under the revaluation model it is shown at its:
• fair value at date of revaluation (the initial recognition of the asset must, however, always
be at cost, never at a revalued fair value)
• less any subsequent accumulated amortisation and any accumulated impairment losses.
The revaluation must be performed with sufficient regularity that the intangible asset’s
carrying amount does not differ significantly from its fair value. The frequency of the
revaluations is dependant on the:
• volatility of the market prices of the asset; and
• the materiality of the expected difference between the carrying amount and fair value.
A downside to adopting this model is that if an asset is to be revalued, all assets in that same
class must be revalued at the same time. This makes it a costly alternative to the cost model.
The mechanisms used in applying the revaluation model to intangible assets are just the same
as those used to apply the revaluation model to property, plant and equipment, with the one
exception being that the fair value of an intangible asset must be determined with reference to
an active market ((there was no such limitation in IAS 16: Property, plant and equipment). As
mentioned already, there is often no active market for the intangible asset due to its uniqueness
and therefore, although the revaluation model is allowed, it is often not possible to apply in
practice. It should be noted that where a fair value has to be estimated on initial acquisition of
an intangible asset, this may be determined in any manner (i.e. with reference to an active
market or by using a calculation).
The following intangible assets do not have active markets due to their uniqueness, with the
result that the revaluation model may never be applied to them:
• brands;
• mastheads;
• music and film publishing rights;
• patents; and
• trademarks.

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If, within a class of assets measured at fair value, there is an intangible asset that does not have
a reliably measurable fair value, then that asset will continue to be carried at cost less
accumulated depreciation and impairment losses.

If the revaluation model is used but at a later stage the fair value is no longer able to be
reliably determined (i.e. there is no longer an active market), the asset should continue to be
carried at the amount determined at the date of the last revaluation less any subsequent
accumulated amortisation and impairment losses.

It should be stressed, however, that if an active market ceases to exist, the possibility of an
impairment in value must also be considered and adjusted for where necessary.

5.2.1 Accounting for a revaluation (IAS 38.80 and .85 - .87)

The revaluation of an intangible asset is accounted for in the same way as that of a tangible
asset (covered by the standard on property, plant and equipment). In summary, two methods of
journalising the adjustment are allowed:

• the gross replacement method; and
• the net replacement method.

The two methods allowed have no impact on the net carrying amount, but do have an impact
on the components thereof: the ‘gross carrying amount’ and the ‘accumulated amortisation’
accounts. This will obviously impact on the note disclosure.

For a detailed discussion of the use of the cost and revaluation models and comprehensive
examples involving both models, please see the chapter on property, plant and equipment.

6. Amortisation and impairment testing (IAS 38.88 - .110)

6.1 Overview

An intangible asset may either be assessed as having:
• a finite useful life; or
• an indefinite useful life.

Assets that have finite lives are amortised whereas those that have indefinite useful lives are
not amortised.

If an asset is assessed as having an indefinite useful life, it does not mean that the asset has
an infinite useful life but rather that ‘there is no foreseeable limit over which the asset is
expected to generate net cash inflows for the entity’. The factors to consider when assessing
the useful life as finite or indefinite are listed in IAS 38.90.

Examples of some of these factors are:
• possible obsolescence expected as a result of technological changes;
• the stability of the industry in which the asset operates;
• the stability of the market demand for the asset’s output;
• expected actions by competitors;
• the level of maintenance required to be assured of obtaining the expected future economic
benefits and managements intent and ability to provide such maintenance.

The impairment testing of intangible assets is generally the same as that of an item of
property, plant and equipment. Impairment testing of both types of asset is covered in
IAS 36: impairment of assets.

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6.2 Impairment testing (IAS 36.111 and IAS 38)

Intangible assets that have finite useful lives are tested in the same way as property, plant and
equipment are tested for impairment:
• Impairment test is first performed to identify whether there is a possible impairment;
• then, if there appears to be a material impairment, and this is not considered to be due to
a shortage of amortisation in the past, the recoverable amount is calculated and
compared to the carrying amount.

The impairment testing is, however, slightly different in the case of:
• goodwill;
• intangible assets not yet available for use; and
• intangible assets with indefinite useful lives.

In the case of all three above, the recoverable amount must be estimated every year
irrespective of whether there is any indications that suggests a possible impairment (in other
words, it is not necessary to perform an impairment test).

In the case of goodwill, the recoverable amount must be calculated:
• annually and
• whenever there is an indication of a possible impairment (IFRS 3.55 and IAS 36.96); but
• Specific exceptions may allow the entity to use a recent detailed calculation of
recoverable amount for a cash-generating unit to which goodwill has been allocated (i.e.
instead of performing an entirely new calculation). These exceptions are found in
IAS 36.99 and are covered in more depth in the chapter on impairment of assets.
• An impairment of goodwill may never be reversed (IAS 36.124 and 90).

In the case of intangible assets that are not yet available for use, the recoverable amount
must be calculated:
• annually; and
• whenever there is an indication of a possible impairment.

In the case of intangible assets with indefinite useful lives the recoverable amount must be
calculated:
• annually and
• whenever there is an indication of a possible impairment; but
• if there is a recent detailed estimate made in a preceding year this may be used instead:
• if this intangible asset is part of a cash-generating unit, where the change in the values
of the assets and liabilities within the cash-generating unit are insignificant;
• if the most recent detailed estimate of the recoverable amount was substantially
greater than the carrying amount at the time; and
• if events and circumstances subsequent to the calculation of the previous recoverable
amount suggest that there is only a remote chance that the current recoverable amount
would now be less than the carrying amount (IAS 36:24).

6.3 Amortisation (IAS 38.97 - .106)

Only intangible assets with finite lives are amortised (IAS 38.97). There are three variables
to amortisation (just as there are to depreciation):
• Residual value (used in determining the depreciable amount);
• Period of amortisation; and
• Method of amortisation.

6.3.1 Depreciable amount and the residual value (IAS 36.100 - .103)

The depreciable amount is:
• the cost (or other substituted amount) of the asset
• less its residual value.

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The residual value is determined (just as with property, plant and equipment) as:
• the expected proceeds on disposal of the asset
• less expected costs of disposal
• imagining the asset to already be at the end of its useful life (i.e. current values are used).

In the case of intangible assets, the residual value is zero unless:
• a third party has committed to purchasing the asset at the end of its useful life; or
• there is an active market for that asset and
- it is possible to determine the residual value using such market and
- it is probable that the market will still exist at the end of the asset’s useful life.

6.3.2 Period of amortisation (IAS 36.97 - .99)

Amortisation of the intangible asset should begin from the date on which it becomes
available for use (i.e. not from when the entity actually starts to use the asset).

Amortisation should cease when the asset is derecognised or if and when it is reclassified as
a non-current asset held for sale, whichever comes first.

The amortisation period should be the shorter of:
• the asset’s expected economic useful life; and
• its legal life.

The asset’s expected economic useful life could be determined as the:
• expected number of years that it will be used; or
• the number of expected units of production.

Where the asset has a limited legal life (i.e. where related future economic benefits are
controlled via legal rights granted for a finite period), the expected economic useful life will
be limited to the period of the legal rights, if this is shorter, unless:
• the legal rights are renewable by the entity; and
• there is evidence to suggest that the rights will be renewed; and
• the costs of renewal are not significant.

Example 7: renewable rights

Ace Ltd purchased a 5 year fishing licence for C100 000. The company expects to renew the
licence at the end of the 5 year period for a further 5 years. The government has indicated that
they will re-grant the licence to Ace Ltd.
Required:
Discuss the number of years over which the licence should be amortised, assuming that the
costs associated with the renewal is:
A. C100; or
B. C99 000.

Solution to example 7A: renewable rights – insignificant cost

As the costs associated with the renewal are insignificant, the asset must be amortised over the 10 year
useful life. The entity intends to renew the licence and the government intends to re-issue the licence to
Ace Ltd, and therefore it must be treated as an asset with a 10 year useful life.

Solution to example 7B: renewable rights – significant cost

As the costs associated with the renewal are significant, and almost equaling the initial cost of the
licence, the asset must be amortised over the 5 year useful life. Although the entity intends to renew the
licence, the renewed licence, when it is acquired, must be treated a separate asset and amortised over a
useful life of 5 years.

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6.3.3 Method of amortisation (IAS 38.97 - .98)
The method used should be a systematic one that reflects the pattern in which the entity
expects to use the asset. The methods possible include:
• straight-line
• reducing balance
• unit of production method.
If the pattern cannot be reliably estimated, then the straight-line method should be used. In
fact, IAS 38 suggests that there is rarely a justifiable situation in which the method used
‘results in a lower amount of accumulated amortisation’ than had the straight-line method
been used instead.
6.4 Annual review (IAS 38.102 and .104 and IAS 36)
At the end of each financial period, the following should be reviewed in respect of intangible
assets with finite useful lives:
• amortisation period;
• amortisation method;
• residual value; and
• recoverable amount (if the annual test of impairment suggest an impairment: IAS 36).
If either the amortisation period or method is to be changed, the change should be treated as
a change in estimate (IAS 8).

If the residual value is to change, adjustments must be made either in terms of an impairment
loss (IAS 36), or if this is not applicable, in terms of a change in estimate instead (IAS 8).
6.5 Intangible assets with indefinite useful lives (IAS 38.107 - .110)
Although already mentioned above under the separate headings of amortisation and
impairment testing, it is useful to summarise the situation relating to intangible assets that
have indefinite useful lives. An intangible asset with an indefinite useful life is:
• not amortised; but is
• tested every year for impairment.
Impairment testing of these intangible assets are done annually:
• where the recoverable amount must be calculated irrespective of whether the impairment
test suggests an impairment; although
• the most recent detailed calculation of the recoverable amount may be used instead, if
certain criteria are met (IAS 36:24) (see the chapter on impairment of assets for more
information).
The status of the intangible asset as one that has an indefinite useful life must be:
• re-assessed every year to confirm that the assessment of its useful life as indefinite is still
appropriate. If circumstances have changed and the useful life is now thought to be finite:
• adjust the amortisation as a change in estimate (IAS 8);
• check for a possible impairment and record an impairment loss if necessary (IAS 36).
6.6 Intangible assets not yet available for use (IAS 38.97 and IAS 36)
Similarly, although already mentioned above under the separate headings of amortisation and
impairment testing, it is useful to summarise the situation relating to intangible assets that are
not yet available for use.
An intangible asset that is still not yet available for use is:
• not amortised; but is
• tested every year for impairment
• at any time but at the same time each year
• where the recoverable amount must be calculated even if the test of impairment does
not suggest an impairment.

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7. Disclosure (IAS 38.118 - .128)

7.1 In general

Information should be provided for each class of intangible asset, distinguishing between
intangible assets that have been:
• internally generated and
• acquired in another manner.

The following information is required for all intangible assets:
• whether the asset has an indefinite or finite useful life;
• if the asset has an indefinite useful life:
- the carrying amount of the asset; and
- the reasons (and significant factors supporting these reasons) for assessing the life as
indefinite;
• if the asset has a finite useful life, disclose:
- the methods of amortisation;
- the period of amortisation or the rate of amortisation;
- the line item in the statement of comprehensive income in which amortisation is
included;
• ‘Gross carrying amount’ and ‘accumulated amortisation and impairment losses’ at the
beginning and end of each period;
• A reconciliation between the ‘net carrying amount’ at the beginning and end of the period
separately disclosing each of the following where applicable:
- additions (separately identifying those acquired through internal development,
acquired separately and acquired through a business combination);
- retirements and disposals;
- amortisation;
- impairment losses recognised in the statement of comprehensive income;
- impairment losses reversed through the statement of comprehensive income;
- increases in a related revaluation surplus;
- decreases in a related revaluation surplus;
- foreign exchange differences; and
- other movements.
Assets classified as held for sale or included in a disposal groupclassified as held for sale
in accordance with IFRS and other disposal
The following information is required but need not be categorised into ‘internally generated’
and ‘acquired in another manner’:
• The existence and carrying amounts of intangible assets:
- where there are restrictions on title; or
- that have been pledged as security for a liability;
• Where an intangible asset is material to the entity’s financial statements, the nature, carrying
amount and the remaining amortisation period thereof must be disclosed;
• Where intangible assets are carried under the revaluation model, the following should be
disclosed by class of asset (unless otherwise indicated):
- the effective date of the revaluation;
- the carrying amount of the intangible asset;
- the carrying amount that would have been recognised in the financial statements had the
cost model been applied;

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- a reconciliation between the opening balance and closing balance of that portion of the
revaluation surplus relating to intangible assets, indicating the movement for the period
together with any restrictions on the distribution of the balance to the shareholders; and
- the methods used and significant assumptions made when estimating fair values.
• Information relating to impaired intangible assets: should be disclosed in accordance with
the standard on impairment of assets.
• Information relating to changes in estimates: should be disclosed in accordance with the
standard on accounting policies, estimates and errors.
• Research and development costs expensed during the period must be disclosed in aggregate.
• Where there are contractual commitments for the acquisition of intangible assets, the amount
thereof must be disclosed.
• Where the intangible asset was acquired by way of government grant and initially recorded
at fair value rather than at its nominal value, then its initial fair value, its carrying amount
and whether the cost or revaluation model is being applied thereto must be disclosed.

Since the following information is considered to be useful to the users, the disclosure thereof is
encouraged, but it is not required:
• A description of: fully amortised intangible assets that are still being used; and
• A description of: significant intangible assets that are controlled by the entity but which
were not allowed to be recognised as assets.

7.2 Sample disclosure involving intangible assets (excluding goodwill)

Company name
Statement of comprehensive income (extracts)
For the year ended 31 December 20X2
Notes 20X2 20X1
C C
Profit for the period xxx xxx
Other comprehensive income(net of tax) 7 xxx (xxx)
Revaluation surplus / (devaluation) xxx (xxx)

Total comprehensive income xxx xxx

Company name
Statement of changes in equity (extracts)
For the year ended 31 December 20X2
Revaluation Retained
surplus earnings Total
C C C
Balance at 1 January 20X1 xxx xxx xxx
Total comprehensive income (xxx) xxx xxx
Realised portion transferred to retained earnings (xxx) xxx 0
Balance at 31 December 20X1 xxx xxx xxx
Total comprehensive income xxx xxx xxx
Realised portion transferred to retained earnings (xxx) xxx 0
Balance at 31 December 20X2 xxx xxx xxx

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Company name
Note 20X2 20X1
ASSETS C C
Non-current Assets
Property, plant and equipment xxx xxx
Intangible assets 4 xxx xxx

Company name
Notes to the financial statements
For the year ended 31 December 20X2 (extracts)
2. Accounting policies
2.3 Intangible assets
Amortisation is provided on all intangible assets over the expected economic useful life to expected
residual values of zero unless the intangible asset has no foreseeable limit to the period over which
future economic benefits will be generated.
The following rates and methods have been used:
Patent (purchased): 20% per annum, straight-line method
Development (internally generated): 10% per annum, straight-line method
Fishing licence (purchased): indefinite
The fishing licence is considered to have an indefinite life since the period of the licence is not
limited in any way other than the meeting of certain prescribed targets that have been more than
adequately met in the past and are expected to continue to be met in the future.
The fishing licence is revalued annually to fair values and is thus carried at fair value less
accumulated impairment losses. The fair value of the fishing licence is determined by way of a
discounted cash flow projection where a discount factor of 10% was considered appropriate.
All other intangible assets are carried at historic cost less accumulated depreciation and impairment
losses.
At the end of each reporting period the company reviews the carrying amount of the intangible
assets to determine whether there is any indication that those assets have suffered an impairment
loss. If any such indication exists, the recoverable amount of the assets is estimated in order to
determine the extent of the impairment loss.

4. Intangible assets 20X2 20X1
C C
Patent xxx xxx
Development xxx xxx
Fishing licence xxx xxx
xxx xxx
Patent
Net carrying amount - opening balance xxx xxx
Gross carrying amount xxx xxx
Accumulated amortisation and impairment losses (xxx) (xxx)
Additions
- through separate acquisition xxx xxx
- through internal development xxx xxx
- through business combination xxx xxx
Less retirements and disposals (xxx) (xxx)
Add reversal of previous impairment loss/ less impairment loss xxx (xxx)
(recognised in the statement of comprehensive income)
Less amortisation for the period (xxx) (xxx)

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Net exchange differences on translation into presentation currency xxx (xxx)
Other movements (xxx) xxx
Net carrying amount - closing balance xxx xxx
The amortisation of the patent is included in cost of sales.
The patent has been offered as security for the loan liability (see note …).

Company name
For the year ended 31 December 20X2 (extracts) continued …
Development
Additions
- through business combination
Add reversal of previous impairment loss/ less impairment loss xxx (xxx)
(recognised in the statement of comprehensive income)
Less amortisation for the period (xxx) (xxx)
Other movements (xxx) xxx
The amortisation of the development asset is included in cost of sales.
The development asset is material to the entity. The following information is relevant:
Carrying amount Detailed above
Nature Design, construction and testing of a new product
Remaining amortisation period 7 years
Fishing licence
Net carrying amount: 1 January xxx xxx
Gross carrying amount: xxx xxx
Accumulated amortisation and impairment losses: (xxx) (xxx)

Additions
- through business combination
Add revaluation/ less devaluation: credited/ debited to revaluation xxx (xxx)
surplus
Impairment loss/ Impairment loss reversed xxx xxx
Net carrying amount: 31 December xxx xxx
Gross carrying amount: xxx xxx
Accumulated amortisation and impairment losses: (xxx) (xxx)

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The amortisation of the fishing licence is included in cost of sales.
The last revaluation was performed on 1/1/20X2 by an independent sworn appraiser to the fair value
estimated using discounted cash flow projection and assuming a discount rate of 10%. The fair value
adjustment was recorded on a net replacement value basis. Revaluations are performed annually.
Carrying amount had the cost model been used instead: xxx xxx

Company name
20X2 20X1
7. Tax effects of components of other comprehensive income C C

Revaluation surplus / (devaluation)
- Gross xxx (xxx)
- Tax (xxx) xxx
- Net xxx (xxx)

22. Profit before tax 20X2 20X1
C C
Profit before tax is stated after taking the following disclosable (income)/ expenses into account:
- Research and development xxx xxx
- Impairment losses xxx xxx
- Reversals of previous impairment losses (xxx) (xxx)

35. Contractual commitments

The company is contractually committed to purchase Cxxx of fishing licences.

8. Goodwill

8.1 Overview

Goodwill is described as the synergy between the identifiable assets or individual assets that
could not be recognised as assets. There are two distinct types of goodwill:
• purchased goodwill (covered by IFRS 3); and
• internally generated goodwill (covered by IAS 38).

8.2 Internally generated goodwill

Internally generated goodwill is never capitalised since:
• it is not identifiable (i.e. is neither separable from the business nor does it arise from
contractual rights);
• it simply cannot be measured reliably; and
• it is not controllable (e.g. can’t control customer loyalty) (IAS 38.49).

8.3 Purchased goodwill

Purchased goodwill arises on the acquisition of another entity. It is measured as follows:

Amount paid for the entity - net asset value of the entity

Purchased goodwill may be divided into two separate categories:
• goodwill (where the purchase price exceeds the net asset value); and
• excess of acquirer’s interest in the net fair value of acquiree’s identifiable assets, liabilities
and contingent liabilities over cost (where the net asset value exceeds the purchase price):
this is often referred to as negative goodwill.

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8.3.1 Positive goodwill

Goodwill occurs when the amount paid for the assets exceeds the value of the assets. This
goodwill is:
• always capitalised;
• never amortised;
• tested annually for impairment.

With regard to the testing of goodwill for impairment:
• the test may occur any time so long as it is done at the same time every year;
• the recoverable amount must always be calculated even if the test of impairment does not
suggest a possible impairment;
• any impairment loss written off against goodwill may never be reversed.

Purchased positive goodwill is therefore held as an asset in the statement of comprehensive
income at its carrying amount, being ‘cost less accumulated impairment losses’.

Example 8: positive purchased goodwill
C
Purchase price of business 100 000
Net asset value of business 80 000

Required:
Journalise the acquisition (ignore any tax effects).

Solution to example 8: positive purchased goodwill

Debit Credit
Goodwill (asset) 20 000
Net assets 80 000
Bank 100 000
Acquisition of a business worth C80 000 for an amount of C100 000

The recoverable amount of this goodwill must be assessed at year-end and if found to be less than
C20 000, this goodwill will need to be impaired.

8.3.2 Negative goodwill

When the value of the assets acquired exceeds the amount paid for these assets we have what
is referred to as the excess of acquirer’s interest in the net fair value of acquiree’s identifiable
assets, liabilities and contingent liabilities over cost. This is just an incredibly clumsy way of
saying we have purchased negative goodwill.

Purchased negative goodwill is recognised as income immediately.
Negative goodwill sounds like a ‘bad thing’ and yet it is treated as income. It will make more
sense if you consider some of the situations in which negative goodwill arises (the first two
situations are obviously ‘win situations’ for the purchaser and should help to understand why
it is considered to be income):
• The seller made a mistake and set the price too low
• The selling price is simply a bargain price
• The entity that is purchased is expecting to make losses in the future.

In the third situation above, the negative income is recognised as income in anticipation of the
future losses (i.e. over a period of time, the negative goodwill income will effectively be set-
off against the future losses).

285 Chapter 7


Example 9: negative purchased goodwill

Purchase price of business C100 000
Net asset value of business C750 000

Required:
Journalise the acquisition of this business (ignore any tax effects).

Solution to example 9: negative purchased goodwill

Debit Credit

Net assets 750 000
Bank 100 000
Negative goodwill (income) 650 000
Acquisition of a business worth C750 000 for an amount of C100 000

8.3.3 Initial recognition determined provisionally

When the fair value of certain assets or liabilities acquired in a business combination can only
be provisionally estimated at the date of acquisition, these assets and liabilities must be
measured at the provisional fair values and the goodwill accounted for as the difference
between the purchase price and these provisional fair values.

The provisional fair values must, however, be finalised within twelve months from
acquisition date. When the ‘provisional’ values are finalised, the comparatives must be
restated from the acquisition date, as if the asset value was known with certainty at the
purchase date (IFRS 3.61-62 and IFRS 3 illustrative example 7).

Example 10: provisional accounting of fair values

Doc Limited purchased Nurse Limited on the 30 November 20X5 for C80 000. The fair value
of Nurse Limited’s plant (its only asset) could not be determined by the independent appraiser
in time for the 31 December 20X5 year end. The fair value of the plant was provisionally
determined as C36 000. The useful life of the plant was estimated on date of acquisition to be
10 years (with a nil residual value expected).

On the 30 September 20X6 the valuation of the plant was estimated provisionally to be
C42 000.

Required:
Discuss how the acquisition should be accounted for in the financial statements of Doc
Limited for the years ended 31 December 20X5 and 20X6.
Provide journal entries where this will aid in your explanation.

Solution to example 10: provisional accounting of fair values

In the 20X5 financial statements the plant must be recognised at the provisional valuation of C36 000,
and the goodwill at 44 000. One month depreciation would be recorded at C300, calculated at
C36 000/10years x 1/12 months.

30 November 20X5 Debit Credit
Plant: cost Given 36 000
Goodwill Balancing 44 000
Bank Given 80 000
Acquisition of Nurse Limited at provisional fair values

286 Chapter 7


31 December 20X5 Debit Credit
Depreciation – plant 36 000 / 10 x 1 / 12 300
Plant: accumulated depreciation Given 300
Depreciation of plant (acquired through acquisition of Nurse Limited)

The 20X5 financial statements would therefore have included the following:
Goodwill 44 000
Plant 35 700 (36 000 – 300 depreciation)
Depreciation 300

During September 20X6 the valuation was finalised and thus the asset must be accounted for as if we
knew the true fair values at acquisition date. The following adjustments would therefore need to be
processed in 20X6:

30 September 20X6 Debit Credit
Plant: cost 42 000 – 36 000 6 000
Goodwill 6 000
Adjustment to fair values of the assets acquired through acquisition of
Nurse Limited

31 December 20X6
Retained earnings (1) 6 000 / 10 x 1 / 12 50
Plant: accumulated depreciation Given 50
Adjustment to20X5 depreciation of plant

(1) Notice that retained earnings are debited (not depreciation expense: this is because the adjustment
is retroactive and is not to affect this year’s profit (i.e. it must not affect the 20X6 profit).

The comparative 20X5 financial statements would therefore be restated as follows:
Goodwill 38 000 (44 000 estimate – 6 000 adjustment)
Plant 41 650 (36 000 + 6 000 adjustment – 300 depreciation – 50 adjustment)
Depreciation 350 (42 000/ 10 x 1/ 12)

Plant is depreciated in 20X6. The following journal would therefore be processed:

31 December 20X6 Debit Credit
Depreciation – plant 42 000 / 10 years; or 4 200
(42 000 – 350) / (120– 1) x 12 months
Plant: accumulated depreciation Given 4 200
Depreciation of plant (acquired through acquisition of Nurse Limited)

The 20X6 financial statements would therefore reflect the following:
Goodwill 38 000 (assuming no impairment necessary)
Plant 37 450 (41 650 – 4 200)
Depreciation 4 200

8.3.4 Adjustment in the initial accounting

Except for the possible need to re-estimate fair values on date of acquisition (explained
above), the only other subsequent adjustments to the fair values of the acquisition of assets,
liabilities and goodwill acquired in a business combination would be the correction of any
errors (IFRS 3.63). The correction of such an error would need to be adjusted for
retrospectively and disclosed in accordance with the standard on accounting policies,
estimates and errors (IAS 8). See IFRS 3’s illustrative examples 8 and 9 for more on this.

287 Chapter 7


8.4 Disclosure of goodwill

8.4.1 Disclosure: positive goodwill
The following information should be disclosed for goodwill:
• a reconciliation between the opening and closing balances of goodwill (separately
disclosing gross carrying amount and accumulated impairment losses), additions,
disposals, adjustments relating to changes to the net asset value of the acquired entity,
impairment losses, net exchange differences arising during the year and any other
movement during the period.

8.4.2 Disclosure: negative goodwill
The following disclosure only applies to any excess of acquirer’s interest in the net fair value
of acquiree’s identifiable assets, liabilities and contingent liabilities over cost:
• a breakdown of the line item in the statement of comprehensive income in which the
negative goodwill is recognised as income.
The negative goodwill income in the statement of comprehensive income should be disclosed
separately in the profit before tax note in the notes to the financial statements

8.4.3 Sample disclosure involving goodwill

Company name
ASSETS Note 20X2 20X1
Non-current Assets C C
Property, plant and equipment xxx xxx
Goodwill 3 xxx xxx
Intangible assets 4 xxx xxx

Company name
For the year ended 31 December 20X2 (extracts)

2. Accounting policies
2.5 Goodwill
Goodwill arising from the acquisition of a subsidiary/Joint venture represents the excess of the cost
of the acquisition over the group’s interest in the net fair value of the assets, liabilities and
contingent liabilities of the aquiree.
Goodwill is measured at the cost less accumulated impairment.

2. Profit before tax 20X2 20X1
C C
Profit before tax is stated after taking the following disclosable (income)/ expenses into account:
Negative goodwill (xxx) (xxx)
Impairment loss on goodwill xxx xxx

288 Chapter 7


Company name

3. Goodwill 20X2 20X1
C C
Gross carrying amount - opening balance xxx xxx
Accumulated amortisation and impairment losses - opening balance (xxx) (xxx)

Additions
- through business combination xxx xxx

Less: disposals of subsidiary (xxx) (xxx)

Less: Impairment or Add impairments reversed (xxx) (xxx)

Gross carrying amount - closing balance xxx xxx
Accumulated amortisation and impairment losses - closing balance (xxx) (xxx)

289 Chapter 7

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